The Importance of Assessing LSP Liability in PPA
What is Long Service Payment Liability?
In Asia including Hong Kong and Mainland China, employees are entitled to severance payments or long service payments (LSPs) upon termination of employment after a specified period of service, provided certain conditions are met. These liabilities, governed by labor laws, represent a significant deferred compensation obligation for employers.
LSP liabilities are typically tied to an employee’s years of service and salary, making them long-term obligations that can fluctuate due to factors such as wage inflation, employee turnover, and changes in legal requirements.
Why Include LSP Liability in Purchase Price Allocation?
PPA is a critical step in any M&A process. It involves allocating the purchase price paid for an acquisition among the identifiable assets and liabilities of the acquired company at their fair values. Here’s why LSP liability assessment plays a pivotal role in this process:
- 1
Accurate Financial Representation
Neglecting LSP liabilities can lead to an overstatement of net assets or goodwill. By recognizing this liability, buyers can paint an accurate financial picture of the acquired company and avoid surprises in future financial statements.
- 2
Compliance with Accounting Standards
Under standards such as Business Combinations or IFRS 3, companies must allocate the purchase price to all identifiable liabilities, including long service obligations. Failure to account for LSP liabilities could lead to non-compliance with these standards, risking financial restatements or audit issues.
- 3
Strategic Planning and Cost Forecasting
Understanding the extent of LSP obligations allows acquirers to anticipate future cash outflows. This insight is crucial for post-acquisition integration planning, workforce restructuring, and ensuring the acquired entity’s financial stability.
- 4
Impact on Valuation and Negotiations
Assessing LSP liabilities provides a more realistic valuation of the target company. Armed with this knowledge, buyers can negotiate better terms and avoid overpaying for the acquisition.
- 5
Risk Management
Unrecognized LSP liabilities can become hidden risks. By identifying and measuring them during the PPA process, acquirers can mitigate potential financial and legal exposure.
How to Assess LSP Liability?
Evaluating LSP liabilities during PPA involves actuarial analysis, as the calculation depends on various factors such as employee demographics, historical turnover rates, and projected salary growth. Collaborating with experienced valuation professionals ensures these obligations are measured accurately and incorporated into the PPA.
Conclusion
In the competitive and fast-paced world of M&A, the devil is in the details. The assessment of long service payment liability is more than a compliance exercise—it is a strategic step in achieving an accurate valuation, managing risks, and setting the foundation for post-acquisition success. Companies undertaking acquisitions must prioritize this evaluation to enhance transparency and safeguard their financial interests.
For a comprehensive approach to LSP liability assessment and purchase price allocation, connect with Valtech team today!